A limited partnership operates similar to a general partnership. In an LP business, there are two or more partners where at least one is considered a general partner and another is a limited partner who is a passive investor and not actively involved in the business. An LP business is also taxed like a partnership with the pass-through taxation method. However, the roles of general and limited partners do affect the amount of taxes partners pay.

Pass-Through Taxation

The pass-through taxation method flows the profits and losses of an LP to the partners, who report their shares on their individual tax returns. Their shares of partnership profits and losses are determined by their partnership agreements and are generally proportionate to their percentages of business ownership. For example, if a partner has 50 percent ownership, he gets 50 percent of the profits or losses.

Comparison to Corporate Tax Structure

One of the tax benefits for an LP business is that the pass-through taxation method prevents profits from being double taxed. Since profits are passed to the partners, they are not taxed at the company level. A regular corporation, for example, has its profits taxed at the corporate level and again when they’re distributed to shareholders who report their dividends as income on their individual tax returns. However, one of the advantages to the corporate tax structure over the pass-through taxation method is the ability of a corporation to retain earnings. Most corporations can keep up to $250,000 in profits from being distributed to shareholders and be used for business obligations such as purchasing equipment, building renovations, etc. The pass-through taxation method isn’t structured to retain earnings.

Losses

In the years when business losses are more than the profits, partners in an LP can deduct losses up to their investment amounts in their businesses. If their losses are greater than their investments, they can carry the excess to other years to offset the profitability of those years. Limited partners are able to carry losses back two years and forward for 20 years.

No Self-Employment Tax For Limited Partners

One of the tax breaks in an LP business goes to limited partners. General partners pay self-employment taxes because they’re actively involved in the day-to-day business operations. Self-employment taxes, which are Social Security and Medicare taxes combined, account for 15.3 percent of a partners’ income as of 2013. Limited partners, who don’t participate in the business operations, do not pay self-employment taxes.